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Unformatted text preview: ody is growing to keep their costs down, then
there’s constantly a great deal of capacity in the market,’ Mr. Crandall said. ‘So long as there’s lots of capacity, people have an incentive to cut prices’” (The
New York Times, December 9, 2003). Orientation Preparing and Organizing Yourself
for Success in College In the case of ﬁrms with low operating leverage, such as
grocery chains, the proﬁt margins are small, so ﬁrms do
what they can to improve those margins—even small savings translate to large improvements in proﬁts. In the case
of ﬁrms with high operating leverage, such as airlines, each
additional unit (seat-mile) sold provides a large contribution to proﬁt, so the emphasis is on increasing volume. S Note that although these ﬁrms have the same sales revenue and operating proﬁt, they
have different cost structures. Lo-Lev Company’s cost structure is dominated by variable
costs with a lower contribution margin ratio of .25. Every dollar of sales contributes $.25
toward ﬁxed costs and proﬁt. Hi-Lev Company’s cost structure is dominated by ﬁxed
costs with a higher contribution margin of .75. Every dollar of sales contributes $.75
toward ﬁxed costs and proﬁt.
Suppose that both companies experience a 10 percent increase in sales. Lo-Lev Company’s proﬁt increases by $25,000 ($.25 $100,000), and Hi-Lev Company’s proﬁt in1 Making Yourself Successful in College
creases by $75,000 ($.75 $100,000). Of course, if sales decline, the fall in Hi-Lev’s
proﬁts is much greater than the fall in Lo-Lev’s proﬁts. In general, companies with lower
2 market demands than Reading and
ﬁxed costs have the ability to be more ﬂexible to changes in Approaching Collegedo
companies with higher ﬁxed costs and are better able to survive tough times.a College-Level Vocabulary Margin of Safety 3 Approaching College Assignments: The margin of safety is the excess of projected (or actual) salesReading break-even sales Following Directions
over the Textbooks and margin of safety
level. This tells managers the margin between current sales and the break-even point. In The excess of projected or
a sense, margin of safety indicates the risk of losing money that a company faces, that is, actual sales over the breakthe amount by which sales can fall before the company is in the loss area. The margin of even volume.
safety formula is
Sales volume Break-even sales volume Margin of safety If U-Develop sells 8,000 prints and its break-even volume is 6,250, then its margin of
Sales Breakeven 8,000 6,250
1,750 prints Sales volume could drop by 1,750 prints per month before it incurs a loss, all other
things held constant. In practice, the margin of safety also may be expressed in sales dollars or as a percent of current sales.
The excess of the projected or actual sales volume expressed as a percentage of the
break-even volume is the margin of safety percentage. If U-Develop sells 8,000 prints
and the break-even volume is 6,250 prints, the margin of safety percentage is 22 percent
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